Blame the Economists, Not Economics

Blame the Economists, Not Economics

CAMBRIDGE – As the world economy tumbles off the edge of a precipice, critics of the economics profession are raising questions about its complicity in the current crisis. Rightly so: economists have plenty to answer for.

It was economists who legitimized and popularized the view that unfettered finance was a boon to society. They spoke with near unanimity when it came to the “dangers of government over-regulation.” Their technical expertise – or what seemed like it at the time –�gave them a privileged position as opinion makers, as well as access to the corridors of power.

Very few among them (notable exceptions including Nouriel Roubini and Robert Shiller) raised alarm bells about the crisis to come. Perhaps worse still, the profession has failed to provide helpful guidance in steering the world economy out of its current mess. On Keynesian fiscal stimulus, economists’ views range from “absolutely essential” to “ineffective and harmful.”

On re-regulating finance, there are plenty of good ideas, but little convergence. From the near-consensus on the virtues of a finance-centric model of the world, the economics profession has moved to a near-total absence of consensus on what ought to be done.

So is economics in need of a major shake-up? Should we burn our existing textbooks and rewrite them from scratch?

Actually, no. Without recourse to the economist’s toolkit, we cannot even begin to make sense of the current crisis.

Why, for example, did China’s decision to accumulate foreign reserves result in a mortgage lender in Ohio taking excessive risks? If your answer does not use elements from behavioral economics, agency theory, information economics, and international economics, among others, it is likely to remain seriously incomplete.

The fault lies not with economics, but with economists. The problem is that economists (and those who listen to them) became over-confident in their preferred models of the moment: markets are efficient, financial innovation transfers risk to those best able to bear it, self-regulation works best, and government intervention is ineffective and harmful.

They forgot that there were many other models that led in radically different directions. Hubris creates blind spots. If anything needs fixing, it is the sociology of the profession. The textbooks –�at least those used in advanced courses – are fine.

Non-economists tend to think of economics as a discipline that idolizes markets and a narrow concept of (allocative) efficiency. If the only economics course you take is the typical introductory survey, or if you are a journalist asking an economist for a quick opinion on a policy issue, that is indeed what you will encounter. But take a few more economics courses, or spend some time in advanced seminar rooms, and you will get a different picture.

Labor economists focus not only on how trade unions can distort markets, but also how, under certain conditions, they can enhance productivity. Trade economists study the implications of globalization on inequality within and across countries. Finance theorists have written reams on the consequences of the failure of the “efficient markets” hypothesis. Open-economy macroeconomists examine the instabilities of international finance. Advanced training in economics requires learning about market failures in detail, and about the myriad ways in which governments can help markets work better.

Macroeconomics may be the only applied field within economics in which more training puts greater distance between the specialist and the real world, owing to its reliance on highly unrealistic models that sacrifice relevance to technical rigor. Sadly, in view of today’s needs, macroeconomists have made little progress on policy since John Maynard Keynes explained how economies could get stuck in unemployment due to deficient aggregate demand. Some, like Brad DeLong and Paul Krugman, would say that the field has actually regressed.

Economics is really a toolkit with multiple models – each a different, stylized representation of some aspect of reality. One’s skill as an economist depends on the ability to pick and choose the right model for the situation.

Economics’ richness has not been reflected in public debate because economists have taken far too much license. Instead of presenting menus of options and listing the relevant trade-offs – which is what economics is about – economists have too often conveyed their own social and political preferences. Instead of being analysts, they have been ideologues, favoring one set of social arrangements over others.

Furthermore, economists have been reluctant to share their intellectual doubts with the public, lest they “empower the barbarians.” No economist can be entirely sure that his preferred model is correct. But when he and others advocate it to the exclusion of alternatives, they end up communicating a vastly exaggerated degree of confidence about what course of action is required.

Paradoxically, then, the current disarray within the profession is perhaps a better reflection of the profession’s true value added than its previous misleading consensus. Economics can at best clarify the choices for policy makers; it cannot make those choices for them.

When economists disagree, the world gets exposed to legitimate differences of views on how the economy operates. It is when they agree too much that the public should beware.

Dani Rodrik, Professor of Political Economy at Harvard University’s John F. Kennedy School of Government, is the first recipient of the Social Science Research Council’s Albert O. Hirschman Prize. His latest book is One Economics, Many Recipes: Globalization, Institutions, and Economic Growth.

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7 Responses

…economics is an artform and as such is subject to interpretation. Blindness and over confidence are human traits that plague us all. In the search for understanding, we (the economists and the public) foolishly look for simplicity in an environment where simplicity does not exist… what have we learned? There are many contributors to this failing, not just a few.

In the financial markets, there is a joy of constructing models and scenarios in real time and then debating the relative merits of each. Models that have been proven rigorously are generally considered to be factored into market prices. Some even suggest that “social science” contains the seeds of its own destruction – e.g. the communist party in China may be able to prevent a transition to democracy by studying the same.*

In the economics departments, there is a certain sense of fear that one might venture a hypothesis that is “obviously wrong.” Hair splitting of facts and interpretations occur. References to mounds of other’s research is made. One gets the sense that there are more ideas about economic principles then there are actual economic principles. Representations of ideas are elegant and abstract – but often cumbersome and computationally inefficient. Time for computation is whittled away by classes that need to be taught, talks that must be given around the globe, etc, etc. Attention begins to narrow onto a specific model. Specialists in the associated areas of economics describe the merits of that model. The division of labor pays the opportunity cost of increasing returns offered by interdisciplinary discussion and analysis of global and systemic possibilities. Others herd in the same direction. Policy forms around those opinions, imbalances are created, and crises occur. It is not surprising at all that the economists who have seen the crisis coming have bridged the communication gap between economists and the investment community (and taught investors in turn about excess volatility, animal spirits, market inefficiencies, the need to be more careful in supporting one’s arguments, etc, etc).

It would be very interesting to see what would happen if Harvard or some other schools started an experimental program that would require students to discover their own laws of macroeconomic turning points, systemic dynamics, and crises for the first two years just from case studies of crises as per raw numerical data and primary resources only – no reading of other’s theories allowed. (That would be like the World Bank building a hydro-electric dam in Africa that eventually falls into disrepair… It is much better to muddle-along and muddle through and enter competitive debate with diffusion, crossing, and pruning of memes at first – even involving financial bets to create the right incentives – if high total factor productivity growth rates are to be attained…).

The third year could then present the standard theories and models.

The fourth would require each student to build a model of a class of crises that improves upon existing models – or even creates a new one.

*By the way, China popped its own housing bubble early. They also seem to enjoy developing policy from political-economic case studies of crises.

For example, between 1945 and 1990, Japan’s innovation rate lagged far behind its growth rate from CAPEX. Now that they have run out of innovations to efficiently implement into their economy, their growth rate has stalled and demand has been supported by Keynesian stimulus.

China seems to be headed for the same fate around 2050. Is anyone preparing policies to avoid that scenario or will it catch the global economy by surprise too?

According to the Mortgage Finders Network, the feeling of being turned down for a mortgage is not something that people enjoy. It can make you feel helpless; like you have nowhere to turn. So what are your options? Well, you should not just sit there and give up. You need to become active and make sure you can change things for the good.

It would be very interesting to see what would happen if Harvard or some other schools started an experimental program that would require students to discover their own laws of macroeconomic turning points, systemic dynamics, and crises for the first two years just from case studies of crises as per raw numerical data and primary resources only – no reading of other’s theories allowed. (That would be like the World Bank building a hydro-electric dam in Africa that eventually falls into disrepair…